Lorillard Purchase Could Add To Retailers’ Margins

If Reynolds American does acquire rival Lorillard, it could prove financially beneficial to convenient stores down the road.

By David Bennett, Senior Editor

The possible purchase of Lorillard Inc. (LO) by rival tobacco manufacturer Reynolds American Inc. (RAI) could help retailers’ profit margins relating to future tobacco trade programs, according to one industry analyst.

Such a combined tobacco powerhouse would have significantly improved financial strength and flexibility, with the ability to deliver long-term operating improvements through increased competitiveness. This could mean more enticing and cost-efficient product offerings for retail customers, according to David Bishop, managing partner at Balvor LLC who researches the retail services sector.

“The combined Lorillard-Reynolds company could become more attractive in their trade programs, thus allowing them to execute more of their programs at retail because the retailers will gravitate to where they can earn the most money,” Bishop said. “In the short term, it will take some pressure off retail margins because those (tobacco) companies would be focused on cost reductions to realize the synergies, and they would be able to use that to offset their increase.”

Bishop explained the cost-friendly environment likely wouldn’t be permanent, but could last 2-5 years, spelling positive financial news for convenience stores that sell tobacco products.

“In a business where retailers are seeing their gross margins compressed at a rate of something close to half a percentage point a year, any relief and any deceleration in that compression would be highly valued by the retailers,” he added.

The Financial Times reported this week that Reynolds is offering $60 per share for Lorillard. Some investment analysts, including Bonnie Herzog of Wells Fargo Securities LLC, put the price per share in the neighborhood of $80 per share.

Combined, Herzog said, both tobacco companies would be stronger to compete against industry leader Altria Group Inc. (MO). In addition, the bigger corporation would gain substantial cost savings, maximizing operational and distribution efficiencies by “potentially closing either LO’s or RAI’s plant which makes sense given we expect cig volume declines to accelerate as e-cigs continue to displace volume; leveraging RAI’s U.S.-based e-cig manufacturing and co-development of future generations of e-vapor products.”

Altria Group’s U.S. retail cigarette share is 50%. Reynolds and Lorillard have market shares of about 25% and 15%, respectively.

Neither company has commented on the report.

A “Lorillard-Reynolds company”—either through acquisition or a possible merger—would be a dynamic market choice, not only because of Lorillard’s strong standing in the U.S. menthol market, but their dominant position in the e-cigarette market, Bishop said.

Big Tobacco has been expanding its footprint in the electronic market with its own brands of e-cigarettes: first Lorillard with Blu eCigs, followed by Reynolds with Vuse in limited markets, and Altria Group’s MarkTen, also in limited markets.

Viewed by many as a safer and cheaper alternative to conventional cigarettes, e-cigarettes, in the last few years, have gained a growing foothold in the tobacco market, positive Wall Street attention and distribution into mass-market retailers.

That trend is likely to continue despite uncertainty from the U.S. Food and Drug Administration, which is now exploring avenues that would impose regulations on e-cigarettes similar to those for traditional cigarettes.

Industry stakeholders are also watching an ordinance that would ban the use of e-cigarettes from some California bars, nightclubs, restaurants and some other public places, approved this week by the Los Angeles City Council.

Ray Johnson

This move would not good for retailers. The push for retailers to give up margins comes from PM & RJR. Remember the funding from B&W for Kool. Well you can kiss the Lorillard funding for Newport rack placement good bye if this deal happens. Also look for Blu and the entire e-cig category margins to drop once PM & RJR are in the driver’s seat.

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